2010 NSAC Conference

Fraud in the Workplace

Conrad Davis, CPA/CFF, CFE

Annette Stalker, CPA/CFF/CITP, CFE

Outline Fraud Statistics Test Your Fraud Awareness Level Major Fraud Categories and Schemes A View from the Field

Non-cash larceny Small business embezzlement Financial statement fraud

Participant Knowledge Check Has anyone uncovered fraud in the course of

their normal work function? Do you have a fraud tip-line? How many private industry participants have

an internal audit team? What analytical tools do you use to watch for

fraud?

Fraud Statistics 2008 Report to the Nation on Occupational

Fraud & Abuse Published by the ACFE every two years Based on case studies submitted by CFEs

who investigated the matters

Significance? What percent of annual revenues are lost due

to fraud? Seven percent $994 billion in fraud losses (applied to GDP)

Most common means of detection? Tips (46%), most common since 2002 Accident (20%)

Significance? Results for the Agriculture, Forestry, Fishing

& Hunting industry group: Lowest number of fraud occurrences at 13 (1.4%) Second highest median loss of $450,000 (first

was Telecommunications industry)

Three Major Fraud Categories

$$

Asset Misappropriation

Financial Statement Fraud Corruption

Asset Misappropriation Accounts for 88% of frequency

(was 91% in 2006) Median loss is $150,000 (same in 2006) Major Types

Skimming Larceny Fraudulent Disbursements

$$

Asset Misappropriation

Fraudulent Statements Accounts for 10% of frequency

(same in ‘06) Median loss is $2,000,000 (same in ‘06) Major Types

Financial: over- and under- statements of assets and revenues, concealed liabilities, improper disclosures, improper asset valuations

Non-Financial: employment credentials, internal documents, external documents

Financial Statement Fraud

Corruption Accounts for 27% of frequency

(was 30% in 2006) Median loss is $375,000 (was $538,000 in

2006) Major Types

Bribery (invoice kickbacks, bid rigging) Conflicts of Interest (purchase / sales schemes) Illegal Gratuities

Corruption

Fraud Awareness Quiz

Some material derived from “What’s Your Fraud IQ?” by Andi McNeal, published in Journal ofAccountancy, May 2010.

Copyright American Institute of Certified Public Accountants. Used with permission.

Test Yourself1. What is the purpose of performing a Benford’s Law

analysis?2. How would you pursue suspicions regarding a

purchasing agent and kickbacks?3. Name two signs of deceptive behavior in an

interview situation.4. What is the most common behavioral red flag

exhibited by fraudsters?5. How can you monitor billing functions for possible

embezzlement activity?

1. Benford’s Law Analysis Also known as the “first-digit law” In a population of multidigit financial numbers, the

first digit will be distributed in a predictable way In 30% of the cases, the first digit will be a 1 In 4.6% of the cases, the first digit will be a 9

Many fraudsters fail to take this non-intuitive pattern into consideration

Many analytic software tools available to perform Benford’s Law Analysis

2. Kickbacks Determine potential conflicts among employees (who have

authority or a role in disbursements) and vendors Public records search can provide information on identity of

“vendors” Business filings with the Secretary of State provide ownership

names Available Corporation and LLC information typically include:

Company Directors and Executives Principle business address Date of incorporation Business ID numbers

3. Interview Deception Repeating the interviewer’s questions (buying time to think

of a response) Beginning responses with “honestly” or “to tell the truth”

(can be a liar’s way of attempting to add credibility) Respond with a question such as “Why would I…” (deflect

the question without providing a directly dishonest answer) Several other non-verbal responses may be more subtle but

indicate stress and discomfort (crossing arms, no eye contact, perspiration, change in posture/behavior after ‘friendly’ questions)

4. Behavioral Red Flag Living beyond his or her means

Exibited in 38.6% of cases cited in the ACFE’s 2008 Report to the Nation

Other Red Flags Include: Divorce or family problems (17.1%) Unwillingness to share duties (18.7%) Unusually close relationship with a vendor or

customer (15.2%)

5. Billing Function Analysis Billing is a common target for employee embezzlement Tools to help detect schemes include:

Queries that identify vendors with no listed contact person (indicative of accounts set up solely to submit fraudulent invoices)

Vendor usage on extremely high end (may signal conflict or kickback scheme)

Vendor usage on extremely low end (may signal fraudster testing waters)

Compare vendor and employee contact information (similar address, phone number, tax ID numbers)

Search for duplicate or consecutive invoice numbers from same vendor

Stratify invoice amounts to identify those just below approval thresholds

A View from the Field Example #1 – Non-cash Larceny Fraud Example #2 – Cash Larceny Fraud Example #3 - Financial Statement Fraud Others (as time permits)

1 – Non-cash Larceny Fraud Scenario

Service industry Manager and key employees

Initial predication Decline in profitability

Work performed Analysis of materials used against costs of

service

1 – Non-cash Larceny Fraud Resolution

Weird Claimed oral contract Settled for sale of business on discounted basis

2 – Cash Larceny Fraud Scenario

All cash and accounting authority resident with one long term “trusted” employee

No effective management oversight Initial predication

Vendor inquiry regarding aged and unpaid invoice

2 – Cash Larceny Fraud Work performed

Discovery that bank reconciliations had not been properly performed

Sub-ledgers were not reconciled with General Ledger

Bank deposits were shorted by currency portion Resolution

Pending criminal prosecution (matter turned over to district attorneys office)

3 – Financial Statement Fraud Scenario

Pressure: company losing money, collateral-based loan facility

Auditor not provided with lender examinations Initial predication

Bank collateral review yielded unsatisfactory results

3 – Financial Statement Fraud Results

Review of actual company assets revealed the misrepresentations

Bank called LOC Company no longer had sufficient cash to be a

going concern Management is terminated and charged with

fraud

3 – Financial Statement Fraud Resolution

Company filed for bankruptcy protection Receiver appointed by the courts Calculation of damages is not just the “lost”

assets but the cost of insolvency of the company What happened to the auditors?

Other Case Examples Property Diversion Ponzi Schemes Small Company Embezzlements External Auditor and Internal Investigations

Questions?

Conrad Davis cdavis@ueltzen.com

Annette Stalker annette@ueltzen.com

ACFE Fraud Tools:

http://www.acfe.com/resources/fraud-tools.asp

AICPA JoA Fraud IQ Article: http://journalofaccountancy.com/Issues/2010/May/20102566.htm